At Budget 2016, the government announced that it would change the rules on carried-forward corporate tax losses, relaxing how carried-forward losses could be used by removing the ‘streaming’ provisions and allowing carried-forward losses to be relieved within a group.
The price of flexibility would be a new restriction on the use of carried-forward losses, so that where annual group profits exceed £5 million, only 50% of the excess could be sheltered by carried-forward losses.
The key changes
- the relaxation of the rules for carried-forward losses, allowing carried-forward losses to be relieved against total profits or surrendered within a group, will only apply to losses arising on or after 1 April 2017;
- the 50% restriction on the use of carried-forward losses will apply to profits arising on or after 1 April 2017, regardless of when the losses accrued;
- where accounting periods straddle 1 April 2017, profits or losses will be time-apportioned unless another basis would give a more just and reasonable result;
- the loss restriction and loss relaxation will apply to trading losses, non-trading loan relationship deficits (NTLRDs), management expenses, UK property losses and non-trading losses on intangible fixed assets (i.e. it will not apply to capital losses);
- companies can claim whether or not to use pre-April 2017 trading losses and NTLRDs before other available losses;
- a new terminal carried-forward loss relief will be introduced;
- new ‘loss buying’ rules will prevent post-April 2017 carried-forward losses arising before the company or group’s acquisition from being available to the purchaser’s group for five years; and
- there will be a targeted anti-avoidance rule aimed at preventing arrangements with a main purpose of obtaining a benefit from the loss reform rules.
Pre-April 2017 losses
Currently, carried-forward trading losses can only be set against later profits of the same trade, and NTLRDs can only be set against non-trading profits.
As the rules for the offset of pre-April 2017 losses will be unchanged, companies will still have to apportion profits between trading and non-trading profits. Where a company uses neither pre-April 2017 trading losses nor pre-April 2017 NTLRDs, it can ignore this requirement and produce a simplified calculation. This could either be because it does not have any such pre-April 2017 losses, or because it elects not to use them.
Groups
The definition of a group was a controversial part of the consultation process. The government was concerned that the use of the group relief definition could be abused and allow fragmentation, whereas respondents were concerned that an accounting based definition could lead to private equity backed groups being aggregated. It is proposed that the definition will be based on the group relief definition, with some additional criteria to prevent companies breaking the group definition to obtain their own £5 million allowance.
There will be no rule determining how the £5 million allowance is used within the group.
The current group relief definition will also be used for the purposes of surrendering carried-forward losses to other group companies.
The calculations
At a company level, it is proposed that each company will have to go through the following steps to calculate the carried-forward losses it is able to claim:
- calculate the company’s total profits for the accounting period, before any carried-forward losses and in-year reliefs;
- calculate the amount of in-year relief available against total profits;
- split total profits into trading and non-trading profits (this step can be skipped if there are no pre-April 2017 trading losses or pre-April 2017 NTLRDs being used);
- apply any in-year relief available against total profits, allocating in-year relief to trading and non-trading profits at the company’s discretion (not reducing profits below nil);
- allow an amount of profit equal to the company’s share of the £5 million group allowance to be relieved in full by available carried-forward losses (not reducing profits below nil);
- add together trading and non-trading profits remaining after step 5 to establish the company’s relevant total profits;
- allow up to 50% of the trading profit remaining after step 5 to be relieved with available carried-forward pre-April 2017 trading losses and up to 50% of the non-trading profit remaining after step 5 to be relieved with available carried-forward pre-April 2017 NTLRDs (this step can be skipped if there are no such amounts being used);
- to the extent that losses claimed at step 7 fall below 50% of relevant total profits, allow the remainder of the 50% of relevant total profits to be relieved by available management expenses, UK property losses, non-trading losses on intangible fixed assets, post-April 2017 trading losses and post-April 2017 NTLRDs (the order of relief is at the company’s discretion); and
- if the company has carried-forward losses remaining or there is still capacity within the company to relieve surrendered losses, consider the surrender of carried-forward losses within the group.
Banking companies will have further calculations to perform.
Cessation of a trade or activity
Terminal loss relief, which allows for the relief of losses of the final period against the previous three years’ profits, will remain unchanged. However, responding to concerns that the restriction on the use of carried-forward losses could lead to such losses becoming stranded on cessation, a new terminal carried-forward loss relief is being introduced.
Where a company’s trade ceases and it has unused carried-forward losses, it will be able to set those losses against profits of the final 36 months of the trade without the 50% restriction applying. Post-April 2017 losses can be set against total profits, while pre-2017 trading losses can only be set against profits of the same trade. The profits against which the losses can be carried back are only those arising since 1 April 2017, as the 50% restriction will not apply before that time.
The government is concerned that the increased flexibility for the use of losses could lead to trades and businesses being continued artificially to makes use of losses where the trade or investment business becomes small or negligible. It has therefore proposed rules that will require the streaming of losses and management expenses where the trade, investment or property business becomes small or negligible. Similar rules will also be introduced for NTLRDs and non-trading losses on intangible fixed assets. Finally, when a company has disposed of all of its income producing assets, it can no longer surrender its carried-forward losses to other companies within the group.
Other rules to prevent abuse
As set out above, to prevent loss buying, there will be a rule to prevent carried-forward losses from being available to the purchaser’s group for five years. In addition, the change in ownership rules will be extended, so that they have to be applied for five years after the change in ownership.
The existing rules aimed at preventing carried-forward losses being refreshed will be extended to include UK property losses and non-trading losses on intangible fixed assets.
The existing transfer of deduction will be extended to carried-forward losses.
All of the above is topped off with a targeted anti-avoidance rule.
Interaction with other rules and reliefs
The government has excluded non-trading dividends from profits from the calculation of the loss restriction, as it recognised the potential for companies to elect for these to be taxed, diluting the impact of the loss restriction.
Many other areas identified in the consultation response published on 5 December 2016 as requiring special rules or exemptions were not included in the draft Finance Bill clauses published on 5 December 2016, and are expected by the end of January 2017. These include rules for:
- consortia;
- excess basic life assurance and general annuity business expenses;
- ring fence oil and gas activities;
- real estate investment trusts;
- UK furnished holiday lettings; and
- creative industry reliefs.
It is likely that the rules will continue to evolve as the legislation proceeds through Parliament, and companies and advisers should monitor further changes.
Practical Tip:
Companies and groups with large carried-forward losses should consider modelling how the proposed changes will impact their future corporation tax liabilities.
